Sunday, 4 March 2012

Another Bailout for Greece but More Likely to Follow

Greece was bailed out again last week, and despite a lot of people losing a lot of money, Greece will probably need further funds down the line. Let’s have a look at why this is likely to be the case (despite what politicians in Europe would have you believe).

First, why a second bailout and why now? Discussions with the Greek government about how to deal with its high level of debt had been dragging on. Politicians in Greece were understandably keen to reduce the burden on its citizens who had to suffer amid the slump in the domestic economy. However, the proponents of the bailout, the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF), wanted to impose requirements for the Greek government to slash government spending to deal with the mountain of debt despite the pain this would cause. The negotiations could have continued except for that Greece had to repay 14.5 billion euros worth of debt in March but didn’t have the funds.

The bailout itself is to deal with the sheer size of the debt taken out by the Greek government. The outstanding amount of Greek debt was around 165% of the GDP of Greece in 2011. It is not only the scale of the bonds but also the lack of growth in the Greek economy. This is important for paying back the debt as a larger economy will result in higher tax revenue for the government to reduce the debt. However, the Greek economy shrank around 6.0% in 2011 and is expected to be 3.0% smaller in 2012 with growth forecast to return only in 2014. The economy in Greece may struggle to even achieve these dismal estimates as the cuts to government spending could create a vicious cycle where cuts to spending weaken the economy and result in lower tax revenues which, in turn, increase the size of the necessary spending reductions.

The rescue plan for Greece is expected to cost 130 billion euros with private bond holders “voluntarily” accepting a 53.5% reduction in the value of the bonds. The actual losses for investors in Greek debt is more than this as the deal also involved a reduction in the interest rates on the Greek debt. The lower rates mean that investors will be getting less money than they thought and the value of the debt will in fact be reduced by 75%.

Despite all this, the aim of the bailout is merely to reduce the amount of Greek debt to 120% of GDP by 2020. That is the same relative level as Italy is at now and is a relative amount of debt which is still seen as problematic. So the bailout is not going to solve the problem of high debt. And these plans rely on growth predictions and assumptions about privatization in Greece that many believe are “optimistic” to put it politely. But, everyone from politicians in Greece and Europe and investors were adamant in avoiding a messy default where holders of Greek debt could lose even more and the market for government debt in Europe would have been thrown into disarray.

So, this all points to the likelihood that Greece won’t be leaving the front pages of our newspapers any time soon.